Your credit score can affect your ability to get a loan or a mortgage, but it also determines how much you’ll pay for insurance.
Depending on where they live, drivers with poor credit can pay double to even triple the auto insurance premium of a driver with good credit, according to a study by InsuranceQuotes.com.
If you have fair credit, the report notes that you’ll pay an average of 28 percent more for car insurance than a driver with excellent credit. It gets worse for drivers with poor credit, who pay double (103 percent) the premiums of drivers with good credit.
“Many consumers are unaware that their credit history is being used to not only determine whether they will be approved for a new credit card or mortgage, but also to decide how much they pay for insurance,” says Nick DiUlio, an analyst at insuranceQuotes.com. “With 97 percent of U.S. insurance companies using credit-based insurance scores to determine auto premiums—apart from California, Massachusetts, and Hawaii, where the practice is not allowed—it’s crucial to be educated on how scoring works and how to improve your score.”
It isn’t just your auto insurance at risk, either. Last year, a study by InsuranceQuotes and Quadrant Information Services found that credit scores have a significant impact on your homeowners and renters insurance premiums.
If you have a fair credit score, you’ll pay 36 percent more for home insurance than someone with excellent credit. That’s up from 32 percent in 2015 and 29 percent in 2014. Worse, if you have a poor credit score, your premium more than doubles. The 114 percent increase is up from 100 percent in 2015 and 91 percent in 2014.
So how is any of this possible? Blame the credit-based insurance score (CBIS), which is completely separate from your credit score and helps insurers determine how likely you are to file a claim. Ranging from 100 to 999, the CBIS is used exclusively by insurance companies and is derived from a variety of factors in your consumer credit report. Actuaries claim that the higher your CBIS, the less likely you are to file a claim. Therefore, the higher your CBIS, the lower your car insurance rate.
“Credit-based insurance scores are created using approximately 20 to 30 different aspects of financial data,” DiUlio says, “which means that everything from late payments to outstanding debt is taken into consideration.”
So exactly what credit factors determine how likely you are to file a claim? Well, the insurance companies pull data from credit bureaus Equifax, Experian, and TransUnion and focus on outstanding debt, length of credit history, late payments, collections, bankruptcies, and new applications for credit.
The belief is that bad credit decisions will lead to bad life decisions that insurers will have to pay for. Lamont Boyd, insurance underwriting expert at FICO, says about 95 percent of U.S. home insurers use credit-based insurance scores in states where it’s allowed. California, Maryland, and Massachusetts ban the use of credit in setting home insurance rates.
“Credit-based insurance scores are used by almost every insurance company in the nation because it’s a very good segmentation tool,” Boyd told InsuranceQuotes. “It’s such a powerful tool because it is very, very predictive of future losses. In other words, lower scoring individuals typically have more insurance losses than those in the higher ranges, which means they are more expensive to insure.”
Even those being insured don’t disagree with this approach. According to a survey by Capital One from last year, 66 percent of consumers believe that good credit should afford a person special treatment. Meanwhile, more than half (55 percent) think that bad credit devalues someone’s social status.
As a result, when a driver’s credit score slides from excellent to fair, their auto insurance rates nearly double in Michigan (an 89.6 percent increase) and Utah (87.3%). When that score goes from excellent to poor, however, premiums triple in Alabama (193 percent), Arizona (197 percent), Nevada (209 percent), Utah (223 percent), and Michigan (229 percent).
Related: Road Outrage: Low-Income Drivers Are Charged More for Car Insurance, Even With a Clean Record
Meanwhile, homeowners and renters with fair credit are going to pay a lot more for insurance in Arizona (75 percent increase), Oregon (67 percent), Montana (67 percent), D.C. (65 percent) and Oklahoma (59 percent) than they would if they had excellent credit. If your credit for some reason drops from excellent to poor, you’re more than tripling your premiums in Oregon (234.9 percent), Nevada (235.3 percent), Oklahoma (248 percent), Arizona (269 percent) and South Dakota (288 percent).
Ethically, basing home and auto insurance rates off of factors that have nothing to do with maintaining a home or driving a car is shaky. Boyd says the average American will never see their credit-based insurance score, while other critics note that there is no standard for its use.
“[T]here is a very dramatic economic downside for people who have credit that’s anything less than excellent, and that seems inherently unfair,” Amy Bach, executive director of the San Francisco-based nonprofit United Policyholders, a consumer advocacy organization, told InsuranceQuotes. “They keep telling us this data is predictive, but they don’t know why. And as long as they keep showing that it’s predictive they win and consumers lose.”
That said, policyholders have options if they want to game the system. The best strategy is simply to establish good credit. About 40 percent of your CBIS boils down to paying bills on time. Another 30 percent is based on how much credit card and loan debt you have vs. how much you’re allowed to borrow (your credit utilization ratio).
“For those looking to save money on insurance — not to mention boost their consumer credit —there are a number of best practices to keep in mind,” DiUlio says. “This includes staying up-to-date on paying all credit obligations, not opening new accounts unless absolutely necessary, and keeping credit card balances as low as possible — no more than 30 percent of the maximum borrowing limit.”
Basically, you can use the same strategy to lower your insurance rates as you would to improve your credit score or lower your credit card interest. Both FICO and VantageScore credit scores value on-time payments and low balances above all else — much like the CBIS. The combination of a spotless payment history (35 percent of a FICO score) and the amount of debt a cardholder carries in relation to their credit limit — or their credit utilization (30 percent) — account for nearly two-thirds of a person’s overall credit score. Your mix of credit accounts (10 percent of your score) also matters.
This all affects your ability to lease a car, rent an apartment, obtain a mortgage, qualify for the best rewards credit cards, or do just about anything else that requires sterling credit — including obtaining low car, homeowners, and renters insurance rates.
After speaking with multiple advisors about this through the years for various financial publications, I’ve cobbled together a four-point plan for raising your credit score — which can help lower your insurance premiums, too:
- Fix the errors: Just get a free copy of your credit report directly from the three credit reporting agencies themselves. Review the status of your account, your credit limits and your personal information, and dispute any errors immediately.
- Beg forgiveness: A longtime account holder or a frequent customer with late payment on their record may be able to talk creditors into working out a repayment plan and, afterward, removing the offending mark from record.
- Pay down balances (and pay off bad accounts first): Almost a third of your credit score is based on your utilization ratio, or how much of your available credit limit you’ve used; anything more than 30% (e.g, $3,000 in balances against a $10,000 overall credit limit) is generally considered too high. But unlike making years of consistent, on-time payments, this is a part of your credit score you can improve almost immediately.When paying off debt to boost your credit, “revolving” accounts like credit cards should take priority, especially those with high interest rates. Pay them down as much as possible to whittle away at interest, and transfer balances to cards with lower rates (or zero-percent introductory offers) when possible.
- Increase your credit: Consider this a last resort, as it’s more of a way to game your credit ratio than anything. But if you’re using up, say, $2,500 of your $5,000 available credit, and can somehow open an account with another $5,000 in available credit, you’ll instantly trim your credit utilization rate from 50 percent to a more desirable 25 percent. The key, however, is not to use any of that newfound credit until you’ve paid off the old debt.
Cut up your credit cards, tuck them away, but keep them open — and don’t go applying for a whole bunch of new cards at once.